Who's Fool?

Legislation to modify debit-card interchange fees cannot compete with celebrity
gossip. Yet, exhausted carcasses are carried on stretchers from the senate
office buildings. The Huffington Post explained: "A full 118 ex-government
officials and aides are currently registered to lobby on behalf of banks in
the fee fight... Retailers have signed up at least 124 revolving-door lobbyists....
The flood fills the hallways with lobbyists and deluges the airwaves with ads.
For weeks, Washington's Metro system has been papered with... ads on trains
and station walls."

It is not surprising that lobbying efforts have changed the minds of 19 senators
who formerly aligned themselves with consumers and small banks (to which the
lower fees do not apply.) The legislators have now hopped in bed with Too-Big-to-Fail
Banks. That is politics as we know it. What might be confusing is the about-face
of Federal Reserve Chairman Ben S. Bernanke. He, too, is cohabitating with
Wall Street. Yet - and this is the astounding twist - it was under his signature
that the new regulations were written.

Before discussing the legislation, a few words on the financial stakes. Annual
debit-card interchange fees (generally called "swipe" fees, and, please note:
this tussle does not include credit cards) in the United States were
$16 billion in 2009. The 10 largest banks collected $8 billion. In the opposite
corner are businesses and consumers. Interchange fees are the second largest
expense, after labor, for retailer Target Corporation. It is not clear, but
looks as though this includes debit- and credit-card costs. Studies in countries
where swipe fees have been capped show more than half of the cut show up in
lower retail prices, so the consumer wins. The process of when, and by whom,
fees are paid and received is below.

The history of the legislation is straight-forward. An amendment to the Dodd-Frank
Wall Street Reform and Consumer Protection Act required the Federal Reserve
to decide whether debit card interchange fees are "reasonable." This is referred
to as the "Durbin amendment," named after Senator Richard Durbin of Illinois,
who proposed the change. The Fed's study was added to the Federal Register
on December 28, 2010 (officially: Federal Reserve System 12 CFR Part 235 Debit
Card Interchange Fees and Routing; Proposed Rule). The paper was issued by
the "Board of Governors of the Federal Reserve System," of which Ben Bernanke
is the chairman. The research was the work of others, but the conclusion bears
his signature. Just as a partner at an accounting firm is responsible for an
audit he signs, this is Bernanke's opinion.

The swipe fee is incurred at the point a debit card is used to pay for a transaction.
Many financial institutions issue debit cards. Most banks in the United States
are in either the Visa or MasterCard network.

Visa and MasterCard set the swipe fees in their networks. The merchant (Target,
for example) pays the interchange fee to the card-issuing bank (Chase, for
example). The customer does not see it, but this is an expense (a reduction
in revenue received) for Target or a laundromat. The merchants increase the
price of tires and laundry in compensation. At the same time, this is revenue
for the issuing entity, whether J.P. Morgan (under the Chase brand name), or
the Bailey Building and Loan.

The Federal Reserve's study found "reasonable" fees should be decreased. In
2009, the "average interchange fee for all debit transactions was 44 cents
per transaction....Issuers reported median per-transaction total processing
costs for all types of debit and prepaid card transactions was 11.9 cents." (Fed
study.) The Fed proposed a cap of 12 cents per transaction. This fee allows "for
the recovery of per-transaction variable costs for a large majority of covered
issuers (approximately 80 percent)."

Costs per transaction are, in part, a matter of scale. The aforementioned
Chase, for instance, should have much lower per transaction costs than the
Bailey Building and Loan. The Fed, in its study, proposed that banks with less
than $10 billion in assets be exempted from its proposed cap. They would continue
to receive the average cost per transaction of 44 cents (assuming the 2009
level).

The Fed's study was unsympathetic to large issuers with poor cost controls.
The Federal Reserve Board of Governors' 12 CFR Part 235 states: "The Board
does not believe it is reasonable for the interchange fee to compensate an
issuer for very high per-transaction costs." Footnote 23 (to 12 CFR, etc.)
offers a good reason for this position. It states that PIN debit transactions
(this does not include checkbook transactions) rose from 7 cents per
transaction in the late 1990s to 23 cents in 2009. PIN transactions have been
increasing in proportion to checkbook transactions.

Whether the Board of Governors considered the implications of footnote 23
is theirs to know, but it throws a dishrag on the near unanimous opinion that
technology has created efficiencies and reduced costs, the latter often taking
the form of fewer employees. There is also the question of why, in the land
of whiz-bang digitality, debit-card fees are among the highest. There are no
- 0.0000% - fees in Canada, the country with the highest debt-card usage rate
in the world. It follows that Canadian banks are willing issuers of debit cards
and that they make money without a swipe fee.

Technology has reduced the cost of PIN (electronic) transactions. This raises
the query of whether inept bank management and derivative trading have been
spread across unrelated portions of the Too-Big-to-Fail banks' profit centers.
The Federal Reserve should conduct another study to unearth such gerrymandering,
given the large banks' passion for circuitous accounting.

Recall that on December 28, 2010, Ben Bernanke submitted the Fed's proposal
to reduce swipe fees. On February 17, 2011, the chairman of the Board of Governors
testified before the Senate Banking Committee. Now, he did not think cutting
fees was a good idea. He warned that merchants (stores) might refuse to accept
debit cards issued by small banks because those banks receive higher interchange
fees. Bernanke also cautioned that card networks might be unwilling to operate
a "two-tier" system with different interchange fees (the 12 basis points cap
for banks with assets over $10 billion and 44 basis points for banks with assets
under $10 billion).

We have arrived at the fun part: motives. Motives are rarely clear, usually
confused, so everyone is qualified to play. The long-term contention held here,
that Ben Bernanke is a dimwit; a pedestrian, college administrator who allotted
prime parking spaces to influential faculty; has not persuaded many. (For those
still willing to give it a try, please see: Orwell
Targets Bernanke: An Unteachable Hole in the Air and Ben
Bernanke: The Chauncey Gardiner of Central Banking.) Critics of this conclusion
may be right: their contention being that Bernanke and the Fed serve the bankers
and, likewise, some politicians are also lackeys: look at their campaign contributions.
Senator Durbin implicitly agreed when he said of fellow senator Chuck Schumer
from New York (an opponent of the amendment): "Listen, I know the zip code
for Wall Street and I know what state it's in."

On the same day (February 17) Senator Durbin fired off a reply to the Fed
chairman. In brief: 1 - In January, Visa had already announced it was designing
a 2-tier interchange fee system, 2 - This was not virgin territory since both
Visa and MasterCard already had several different tiers for such categories
as corporate cards, supermarkets, utility bills, and overseas payments, 3 -
merchants could not reject bank cards from smaller banks. It is in their contract
with Visa or MasterCard: "Merchants are subject to severe penalties if they
decline to accept a network's card on the basis of the card's issuer." (Durbin
letter to Bernanke.)

Chairman Bernanke, who, again, authorized the rule changes, had now, on February
17, testified against the rule changes, for reasons that did not apply to the
rule changes.

It is the latter part that is nearly inexplicable. How could Bernanke show
up at a Senate hearing and not know his contentions were factually wrong? He
has 220 Ph.D.'s at the Fed who live and breath to impress the Fed mandarins.
Surely, Fed staffers shared their research (most of which can be read on Visa's
and MasterCard's websites) with the chairman. How did he graduate from the
third grade? One possibility, for both his F-minus performance and third-grade
promotion, is a parallel briefing by the American Bankers Association.

Between December, 2010, and February 17, 2011, a massive battle was waged.
A small mountain of letters and press releases passed between lobbyists, senators,
and special-interest groups. The "nays" won where it matters: senators and
the Fed chairman changed sides.

The ABA wrote to Senator Durbin on February 8, 2011. It aligned itself with
the small banks for the obvious reason that arguing for the interests of J.P.
Morgan or Citigroup is not a vote-getter. The ABA claimed merchants would discriminate
against small banks since those banks with assets under $10 billion would still
charge 44 cents per transaction (all else remaining equal), a greater depletion
of the merchant's revenues than the new 12 cent cap for large banks.

Senator Durbin replied to the ABA on February 11, 2011. He reminded the ABA
(which must have known) that Visa's contract with merchants prohibits such
discriminatory behavior and that Visa had already announced (on January 7,
2011) it "would implement different interchange rate schedules for large and
small banks." Six days later, Simple Ben tried to wing the same bag of baloney
at the same senator.

So, a possible explanation of F-Minus Bernanke: his argument did not matter. "The
Fed chairman opposes the Durbin amendment," was parroted through the hallways
and on the airwaves, all that was needed for day-trading politicians to hide
in the tall grass.

Before moving on to Bernanke's, most-recent, May 12, 2011, testimony, it is
worth a moment to illuminate the characters Bernanke has aligned himself with.
On April 5, 2011, J.P. Morgan Chase's CEO, Jamie Dimon, before the Council
of Institutional Investors, stated the Durbin amendment was "counterproductive" and "downright
idiotic." This is fine thanks to the government that; if not for the good graces
of Geithner, Paulson, and Bernanke; might have thrown Jamie Dimon in a high-security
federal penitentiary where he would now be smashing large rocks into little
rocks as punishment for his bank's reckless behavior leading up to the 2008
financial evaporation.

Dimon whined that J.P. Morgan would have to raise other fees to compensate
for its projected losses. Good. Maybe it is so uncompetitive it will abandon
the debit card business. It could do us all a favor by shutting down the rest
of its Too-Big-to-Fail-or-Save business lines at the same time.

J.P. Morgan Chase also terrorized America's children when it banned them from
Disneyworld. A notice to its customers states: "Congress recently enacted a
new law known as the Durbin Amendment that significantly impacts debit
cards. As a result of this law, we will be changing our debit rewards program.
After July 21, 2011, you will no longer earn Disney Dream Reward Dollars when
you use your Disney Rewards Debit Card."

Senator Durbin replied to Dimon's tantrum on April 12, 2011. He wrote that
those who pay the most for higher swipe fees are the poor. Twenty-five percent
of Americans do not have a bank account, pay with cash, so (quoting the Huffington
Post) there is "no question that the resulting higher prices [that retailers
charge to compensate for swipe fees] hit the poor hardest of all." Durbin reminded
Dimon that last year his bank had $17.4 billion in profits and he was paid
$20.8 million. Bernanke has chosen some fine bedfellows.

It is a strange mix now serving the Morgan Interests: a mothballed phrase
from a century ago that is more fitting now than then. These include the ABA,
the NAACP, the Christian Coalition, Barney Frank (co-author of the Dodd-Frank
Act), Grover Norquist, and leading Tea Party groups Freedom Works and Americans
for Prosperity (from the Huffington Post, which has done an excellent
job of covering the story). Also, the Independent Community Bankers of America
(ICBA), the trade association for small banks, is lobbying against the small
banks, probably to protect the ICBA Bancard, a money-maker of such grand proportions
that it would be subject to the rate caps. (Simon Johnson, New York Times,
May 12, 2011)

On May 12, 2011, Bernanke testified again before the Senate Banking Committee.
When questioned, the chairman stated: "Well, it's going to affect the revenues
of the small issuers and it could result in some smaller banks being less profitable
or even failing." Barney Frank is using Bernanke's misgivings as an excuse
to sandbag his own bill. Senator "Durbin is as exasperated by Frank as he is
by Bernanke. "I don't understand it," he says. "I wrote [Barney Frank] a letter
and asked him... 'What are you doing?' We had long talks when we were writing
this thing, [when we] worked on it together." (Huffington Post)

Ben Bernanke is of a type. Anyone who has worked at a state house or city
hall or court house has met him. The type is common, too, on college campuses
where merit is judged by conformity of thought, submissive allegiance to the
hierarchy (see BB's nauseating, "thanks
to you, we won't do it again," to Milton Friedman, November 8, 2002), and
obedience to the bureaucracy.

George Orwell wrote that the intelligentsia is "power hungry" and (individually) "is
capable of the most flagrant dishonesty, but he is also - since he is conscious
of serving something bigger than himself - unshakeably certain of being right." Orwell
observed from a front-row seat as the apparently powerful shuddered under the
heel and whip like cotton-picking slaves. Writing in 1944: "Hitler's puppet
government are not workingmen, but a gang of bankers," and other specimens
of the type under review.

The type was described by Giorgio Bassani in his novel, The Garden of the
Finzi-Continis. Set in Ferrara, Italy, in the late 1930s, a rising mediocrity
in the Fascist University Students Association (Gino Ciariani, by name) halted
a tennis tournament because a Jewish player was winning. In the words of
an observer at the tennis match, (with a few substitutions, in brackets,
to replace Gino Giariani with Ben Bernanke): "It was all too obvious: dimwit
that he was... [H]is sole thought, from the first moment he had entered [MIT's
graduate school of economics], had been to make a career, and for this reason
he had never overlooked the opportunity, in public or in private, to lick
the feet of [academic economists]. The moment [Hank Paulson] or some other
big shot of the group put him in his place, he promptly tucked his tail between
his legs, capable, to win forgiveness and be restored to favor, of even the
most humble services: running to the tobacconist's to buy the secretary a
pack of Giubek's, [starving elderly Americans by confiscating their interest
rate so Jamie Dimon could make more money].... [A] worm of that sort... surely
hadn't missed the opportunity to show off, once again, for the party officials!"

Sheehan serves as an advisor to investment firms and endowments. He is the
former Director of Asset Allocation Services at John Hancock Financial Services
where he set investment policy and asset allocation for institutional pension
plans. For more than a decade, Sheehan wrote the monthly "Market Outlook" and
quarterly "Market Review" for John Hancock clients.

Sheehan earned an MBA from Columbia Business School and a BS from the U.S.
Naval Academy. He is a Chartered Financial Analyst.